Big Ben

Bernanke's a great choice for Fed chairman, but is he tough enough on inflation?

At last, President Bush has found somebody in the White House who is truly qualified for a senior non-White House appointment. Today, he namedBen Bernanke*, chairman of the Council of Economic Advisers, to replace Federal Reserve Chairman Alan Greenspan.

Economists, usually a back-biting bunch, are nearly universal in their praise for Bernanke. The stock market is pleased, as the key indices are up on the day. The Senate, which has to confirm Bernanke, is enthusiastic as well, with Democratic (Paul Sarbanes) and Republican (Robert Bennett) members of the Senate Banking Committee appearing on CNBC to support the nomination. The punters at Intrade, who had Bernanke as the odds-on favorite, are also surely satisfied: Hey, the guy's middle name is "peace." Literally. Bernanke is an excellent economist with excellent credentials. He's a highly respected scholar who also writes books that are accessible to laypeople. (See his Essays on the Great Depression.) And he's also been blessed with excellent timing. After all, the last few years have not been kind to Republican-leaning academic economists interested in government service. Working in the Bush administration meant selling a set of dishonest fiscal policies, crafting public policies that were anathema to their beliefs (from steel tariffs to the Medicare prescription-drug plan), and occasionally having to disavow their own writings.

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Bernanke was lucky enough (or smart enough) to spend the first term of the Bush administration in the cloisters of Princeton, and then in the economists' equivalent of a monastery—the Federal Reserve, where he was appointed a governor in the fall of 2003 (one of Greenspan's dwarves). At the Fed, Bernanke was responsible for the one bit of weirdness on his résumé: He helped popularize the savings-glut meme, which argues that Europe and Asia are saving too much and profligate consumer and government spending in the United States are saving the global economy.

In June 2005 *, Bernanke left the Fed and entered the White House as the chairman of the Council of Economic Advisers. Again, good timing. When he arrived, the bitter fiscal-policy battles were at a lull and the economy was creating jobs. Bush's disastrously unpopular Social Security plan had essentially been called off, and the short-term budget picture was improving. Between Iraq, Katrina, and the Miers appointment, the news has been dominated by noneconomic issues. And so Bernanke was not called upon to become a salesman for horrid policies, as predecessors Glenn Hubbard and N. Gregory Mankiw were forced to.

So, what's not to like? The suspicion about Bernanke isn't that he's a blinkered ideologue (Greenspan, in fact, was a blinkered ideologue, and he turned out to be a pretty good Federal Reserve chairman), or that he's a political hack. No. The one question about Bernanke is how seriously he takes the threat of inflation and how far he'll be willing to go to stamp it out.

President Bush in his speech today listed several job functions of a Fed chief, many of which may seem opaque to the public: "overseeing the integrity of our banking system ... containing the risk that can arise in financial markets ... ensuring a functioning payment system." But really, what the markets, politicians, and consumers most want from the Federal Reserve is vigilance against inflation.

Some suspect Bernanke of being a little soft on inflation. After all, Bernanke was an instrumental figure in the incipient deflation scare of 2002 and 2003, which gave Greenspan the intellectual justification to push interest rates to record lows and to leave them there. If he was so worried about falling prices, Bernanke might be insufficiently concerned about rising ones.

Now, calling a Fed nominee soft on inflation in 2005 is a little like calling a State Department nominee soft on communism in the 1950s. But how the Federal Reserve deals with the very real threat of inflation is the question Bernanke will face upon assuming office.

Inflation in this economy is real, and not just in food and energy. And some of it may be the Fed's own creation. When Greenspan relentlessly slashed interest rates to emergency lows in 2003, and left them there well into 2004 (with Bernanke's support), it unleashed a tidal wave of liquidity into the economy. Much of that easy money went into commodities, houses, energy, and food—and various other things that are becoming more expensive. As James Grant argues in the current Forbes:"To preserve the nation from an imagined deflation, the Fed instigated a real estate and mortgage inflation."

And so for the past year, Greenspan and the Federal Reserve have been playing catch up. The Fed has raised interest rates 11 straight times, taking the Federal Funds rate from 1 percent in 2004 to 3.75 percent today. There are two more meetings before Greenspan retires, which means Bernanke could enter office in January 2006 with the Federal Funds rate higher than it has been at any time since April 2001. In his first months on the job, Bernanke will likely face some tough questions about how far the Federal Reserve should go in raising rates to fight off inflation, or whether it has already done enough and should just stand pat. And that is the most difficult call a Federal Reserve chairman can make.

*Corrections, Oct. 25, 2005: Gross originally misstated Bernanke's first name. It is Ben, not Benjamin. Gross also erred about the date Bernanke became chairman of the Council of Economic Advisers. He became chairman of the CEA in June 2005, not June 2004. Click here and here to return to the corrected sentences.